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Japan's economy in deep trouble? Look again.

Standard & Poor’s cut its rating on Japanese sovereign debt one notch last week, strengthening the naysayers. But with falling unemployment, large reserves, and rising corporate profits, 'Japan is punching well above its weight,' says one analyst.

By Correspondent / February 2, 2011

A man is reflected on a stock index board as he walks past a brokerage in Tokyo on Jan. 28. Standard & Poor’s (S&P) cut its rating on Japanese sovereign debt one notch last week, the economy has not collapsed and the yen has actually strengthened.

Kim Kyung-Hoon/Reuters

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Tokyo

With sky-high public debt, near-zero interest rates, and an economy that is reportedly a basket case after two decades of stagnation, Japan's currency should be falling through the floor. Instead, the yen’s strength is a challenge to those who seem to believe Japan is sliding into oblivion.

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The downgrading of Japanese government debt by a US ratings agency in late January was the cue for another round of doomsday predictions.

On Jan. 27, Standard & Poor’s (S&P) cut its rating on Japanese sovereign debt one notch, to AA-minus, three levels off the top ranking and on a par with that of fiscally troubled Spain. It argued that the ruling Democratic Party of Japan "lacks a coherent strategy" to address the country's financial woes.

Leaving aside the issue of credibility of the rating agencies, all of which were classifying sub-prime junk bonds as high-grade investments right up to the credit crisis, there is no denying the dire state of Japan’s public finances.

It’s often written that the country has the highest national debt as a percentage of GDP – at around 200 percent – in the OECD or in the industrialized world. In fact, only Zimbabwe’s is higher. The US by comparison, at around 60 percent, is only a touch above the global average.

Still, while the Japanese government issued more new debt than it collected in tax revenue in the last fiscal year, the economy has not collapsed, and the yen has actually strengthened. Investors are largely unconcerned because the debt is virtually all domestically held, and the yields demanded are very low. Japan is also sitting on some very large reserves of assets, unemployment is falling, and profitability is increasing at its major corporations as they benefit from the global recovery and fast-growing Asia.

'Weakness does not explain strength'

And yet the advice on how to fix the economy keeps coming from around the globe, along with claims that Japan is teetering on the edge of the abyss.

“My favorite question for people who hold those views is: ‘If Japan is so weak, why is the yen so strong?’ It’s somewhat of a head-breaking question for those who prefer the view that Japan is weak,” says Scott Callon, chairman of Ichigo Group Holdings, an asset management company with around $5 billion in funds invested exclusively in Japanese companies and real estate. “They typically want to explain yen strength in terms of weakness – the yen is so strong because the Bank of Japan is so weak, or because the political system is fragmented. But this doesn’t make sense... Weakness does not explain strength.”

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“When you buy the yen, by definition you sell another currency, the dollar or the euro or the Australian dollar, etc., against it,” continues Mr. Callon, pointing out the huge size of the global foreign exchange trade. “And that incredibly active and liquid market, representing the collective wisdom of millions of market participants globally, has taken a very strong view on the Japanese currency and the inherent strengths of this country and its economy.”

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